Chapter 15 - Cost Behavior And Cost - Volume - Profit Analysis Flashcards
- Understand the nature of fixed and variable costs. - Appreciate the way in which costs behave over activity levels. - Explain how past costs are measured to predict future costs. - Use cost-volume-profit (CVP) analysis in decision making. - Appreciate the limitation and assumptions underpinning the determination of future costs and revenues.
Key Concept: Variable costs
Variable costs are the same per unit of activity and therefore total variable costs will increase and decrease in direct proportion to the increase and decrease in the activity level. The activity level may be measured in terms of either production/service output or sales output. The choice will depend on what is being measured.
Key Concept: Fixed costs
A cost is fixed if it does not change in response to changes in the level of activity.
Reasons why variable costs are not strictly linear:
- Prices of resources tend to increase as a scarcity arises due to demand.
- Diminishing returns: for example, attempts to sell more units may well entail transporting the extra units over longer distances to reach more distant markets and therefore distribution costs may increase at a faster rate than activity. Assuming that selling prices are constant, these greater distribution costs will result in diminishing profit margins.
Key Concept: The relevant range of activity
The relevant range of activity relates to the levels of activity that the firm has experienced in past periods. It is assumed that in this range the relationship between the independent and dependent variables will be similar to that previously experienced.
Key Concept: Cost estimation
Cost estimation relates to methods that are used to measure past (historical) costs at varying activity levels. These costs will then be employed as the basis to predict future costs that will be used in decision making.
Key Concept: Cost-volume-profit (CVP) analysis
CVP analysis is a tool by organizations to help them make decisions by examining the interrelationships between cost, volume and profit.
profit = sales - (fixed cost + variable cost) or S(x) = VC(x) + FC + P
Definition: Contribution Margin (Bruttogewinn)
The contribution margin is equal to the sales price per unit less the variable costs per unit.
S(x) - VC(x) = C –> Break even: x = FC/C
Definition: Margin of safety
The margin of safety is the amount by which actual output, normally measured in terms of sales, may fall short of the budget without incurring a loss.
